Banco de Chile - Earnings Call - Q1 2025

Transcript

Operator (participant)

Afternoon and welcome to Banco de Chile's Q1 2025 Results Conference Call. If you need a copy of the financial management review, it is available on the company's website. Today with us, we have Mr. Rodrigo Aravena, Chief Economist and Institutional Relations Officer, Mr. Pablo Mejía, Head of Investor Relations, and Daniel Galarce, Head of Financial Control and Capital. Before we begin, I would like to remind you that this call is being recorded, and the information discussed today may include forward-looking statements regarding the company's financial and operating performance. All projections are subject to risks and uncertainties, and actual results may differ materially. Please refer to the detailed notes in the company's press release regarding forward-looking statements. I will now turn the call over, and Mr. Rodrigo Aravena, please go ahead.

Rodrigo Aravena (Chief Economist and Institutional Relations Officer)

Good afternoon, everyone. Thank you very much for joining this conference call. As usual, today we will review the main results and advances in our strategic project during the Q1 of this year. Once again, our bank has confirmed its strong position in the client banking industry, reaffirming its leadership in different areas. In the quarter, the net income was CLP 329 billion, surpassing our peers and achieving an ROAE of 23%. As we will see later in this conference call, these outstanding results were explained by strong margins, improved asset quality, and enhanced efficiency levels. This performance becomes particularly important given the increasing uncertainty of the macroeconomic environment due to the revised foreign trade approach adopted by the U.S. administration, which could likely reduce the global and even local economic growth in the future.

Therefore, our solid fundamentals, such as asset quality, large amounts of additional provisions, and a strong capital base, are undoubtedly aspects that generate even greater differentiation for us, not only in Chile but also at the regional level. Before discussing in detail the financial results of our bank, I would like to share with you our analysis of the current macroenvironment. Please go to slide number three. The Chilean economy has shown a recovery in recent quarters. As can be seen in the graph on the left of this slide, the activity posted an important increase in the second half of 2024, with a peak in the Q4 when the economy grew by 4%. As a result, the country achieved an above-expectation expansion of 2.6% for the year.

The breakdown of the figure, as seen in the top right part, shows that domestic demand, reflected in a strong rise in the commerce sector, was one of the main drivers of greater dynamism. Different factors contributed to this, such as the lagged effect of interest rate cuts, the recovery of aggregate employment, and the temporary effect of foreign purchases in Chile. In addition to these figures, several leading indicators, such as imports of capital and consumer goods, shown in the bottom right chart, are consistent with the existence of favorable expectations regarding domestic demand, at least in the short term, if external risks are set aside. Please go to slide four to analyze the evolution of inflation and interest rates. Inflation has remained above the central bank target of 3% since late 2020, as shown in the graph on the left.

In March, annual inflation was 4.9%, a figure that, although higher than the 4.5% recorded at the end of last year and the 3.7% seen a year ago, it's important to consider the figure posted this year was affected by some temporary factors. Among them, the rise in energy prices, which posted a 14.2% year-on-year increase, which, according to central bank estimates, has contributed almost 130 basis points to annual inflation. Additionally, inflation of tradable goods went up by 5.2% year-on-year, influenced by the weakening of the Chilean peso in 2024. Sequentially, inflation rose by 2% in the Q1 of the year. However, as shown in the chart, the CPI variation, excluding volatiles, is below the change in the headline measure, reflecting the existence of more moderate pressures at the core level. This reassures the fact that inflation has been driven by specific factors, particularly over the last quarters.

Although the recent evolution of inflation has led the central bank to keep the reference rate at 5% in the Q1, it's important to consider that the Chilean overnight rate has dropped the most globally, from the peak of 11.25% in 2023 to the current figure, which, however, remains above neutral levels, between 4% and 4.5%. The path followed by the reference rate has resulted in a steepened yield curve, as shown in the bottom right chart, measured as the difference between the 10-year sovereign rate and the overnight rate in Chilean pesos, which should have a positive effect on banking results, as banking liabilities typically reprice faster than assets due to the duration gap. In this regard, the yield curve is expected to become more positively sloped as the monetary policy rate converts to neutral levels by the end of this year.

Notwithstanding the positive trends seen in the Chilean economy over the last quarter, the recent and abrupt change in global trade conditions is something we must take into consideration, especially given the high integration of the Chilean economy with the rest of the world. However, despite the external risk, Chile has some differentiating strengths that could partially mitigate the potential impact of constrained global trade. Please go to slide number five to analyze them. Although Chile is one of the most open economies in the region, it has a well-diversified export basket in terms of destination. As can be seen in the top right chart, Chile has significant integration with China, a country that represents around 40% of the country's total shipments. If other Asian countries are considered, this region represents, in total, around 60% of Chilean exports. The U.S. economy, in turn, represents 16% of Chile's total exports.

It's also important to mention exemptions for some relevant Chilean products, such as copper, as well as lithium and wood derivatives, as shown in the right graph. Thus, the effective tariff rate on Chilean exports is lower than the 10% rate recently imposed by the U.S. administration. Another aspect to consider is the room to implement countercyclical measures in the event of a recession. Along with the normalization of inflation, which has allowed interest rate cuts by the central bank, Chile has also greater capacity than other countries in the region to implement fiscal policy measures based on lower debt levels and interest rate burden, as shown in the bottom right chart. The [inaudible] very fundamental has been [inaudible] globally. As such, the value of risky financial assets has been less affected in Chile when compared to other comparable countries.

Likewise, it's worth highlighting, for instance, that the value of the peso has been less affected than other currencies, as the bottom left chart shows. Now, I'd like to present our best scenario for the year 2025. Please go to slide six. We expect GDP to expand by 2% in 2025. This figure has several elements to consider. First, it represents less dynamism than in 2024, partly due to the expected slowdown in the global economy and further deceleration of some of Chile's trading partners. The recovering domestic demand would be the driver for GDP growth this year, which would offset a slowdown in exports. This situation would result in a slight decline in CPI inflation that would end up the year below 4%. However, the forecast assumes neither a significant rebound in external inflation nor extreme rate depreciation for the rest of the year.

Under these circumstances, the central bank would reduce the interest rate to a neutral level of around 4.25%. Finally, it's important to take into consideration the higher uncertainty we face, as well as the downside risk in terms of growth, mainly due to global factors. Locally, a source of attention will be the upcoming presidential and parliamentary election in November this year. Before analyzing the bank's result in detail, I'd like to share a brief analysis of trends in the banking industry. Please go to slide seven to discuss it. This quarter return on average equity for the Chilean banking system was 16.5%, which is slightly higher than both previous quarter and the last year, as depicted in the top left graph. This consistent profitability can be attributed to several factors, including effective cost control, diversified income streams, and stabilizing market conditions.

Despite global economic hardships, financial institutions have demonstrated resilience and adaptability in a dynamic landscape. Furthermore, technological and digital advancements are optimizing operations, cutting costs, and enhancing customer experience, directly positively impacting overall financial performance. Regarding business volumes, as shown by the chart on the right, Chile's improved economic performance has not resulted in significant loan growth. Loans increased by 2.6% year-on-year. Mortgages were the primary contributor to this growth, rising by 6.3% year-on-year, while consumer loans increased by 5.1% during the same period. Commercially, commercial loans did not experience any growth in nominal terms. Weak growth in commercial loans has resulted in a change in the portfolio composition compared to pre-pandemic levels. Currently, as shown in the chart on the bottom left, mortgages constitute 36% of total loans, up from 29% in 2019.

During the same period, commercial loans have reduced from 56% to 52%, and the consumer portfolio has decreased from 15% to 12%. This shift in mix, due to weak demand for consumer and commercial loans, led banks to maintain lower-risk portfolios, preventing a significant rise in NPLs, as shown in the chart on the bottom right. Next, Pablo will share information regarding Banco de Chile's development and financial results.

Pablo Mejía (Head of Investor Relations)

Thank you, Rodrigo. Let's begin by turning to slide number nine, which provides a comprehensive view of our strategic framework and midterm targets. Together, they define a roadmap for sustainable value creation. On the left side of the slide is our strategy, structured around three key components: our strategic plan, our strategic pillars, and our purpose. Our strategic plan is built on six areas aimed at transforming the way we operate and serve our customers.

These initiatives are interconnected and designed to make us more agile, competitive, and responsive to the evolving needs of our clients. Supporting this plan are our strategic pillars, which guide us on how we execute our strategy with efficiency and productivity through collaboration and always with a customer-first mindset. These pillars ensure that our operations, culture, and decision-making processes remain aligned with performance and innovation, and finally, at the center of our strategic plan and pillars is our purpose. We aim to support Chile's growth and its citizens and businesses, enhancing our competitive advantages through long-term trust and strong relationships. On the right side of the slide are our midterm targets, show our strategic goals and commitment to measurable results. Return on average capital and reserves, we aim to be the leading bank among peers.

Cost-to-Income Ratio, we're targeting a ratio below 42%, and we're currently operating at 36.1%, outperforming expectations. This result not only is from a strong revenue generation, but also disciplined cost management and strong operating income. Market share, our objective is clear: to lead in commercial loans, consumer loans, and demand deposits in local currency. Currently, we are the leaders in demand deposits and hold second place in both commercial and consumer lending. I'd like to emphasize that we aim to reach these targets by growing responsibly in terms of credit risk. Net Promoter Score, we've exceeded our target of 73%, reaching 75.8% in March 2025. This reflects sustained efforts in improving customer experience through employee training, digital enhancements, and better service models. Corporate reputation, according to 2024 Merco ranking, we've reached top two among all companies in Chile, including banks, surpassing our goal of being in the top three.

This recognition is driven by our broad engagement and social impact initiatives, including education, entrepreneurship, and volunteerism, along with our commitment to ethical and responsible business practices. In summary, we're executing a strategy that is ambitious and disciplined, with a focus on efficiency, customer satisfaction, and sustainability. Our progress is measurable, our foundations are strong, and we're confident in our ability to generate long-term value for our stakeholders. Please move to slide 10, where we'll go over our key business advances in the Q1 of 2025. We have continued advancing in initiatives to drive productivity across the entire organization. Functions from our subsidiaries are being centralized to the bank, and some organizational structure is being continually refined. Additionally, we have sustained our efforts to streamline technology expenses in areas including data centers, cloud, and telecommunications.

These measures are expected not only to optimize costs, but also to enhance our technological capabilities and support our long-term growth objectives. On the digital transformation front, we made many advances this quarter. First, we're proud to be strategically using AI tools. In fact, we've made available AI Copilot chat across the entire organization. This important step forward in using AI is making our workdays more productive, secure, and insightful. We also introduced new products and enhanced existing ones. To name a few, we launched a new credit card and micro-lending product for FAN customers, as well as making changes to the digital student plan to reach a broader university student audience. These and other advances have driven the expansion of our digital accounts, achieving a 21% year-on-year growth in our FAN customer base.

It's also important to note that this has not only expanded our presence in these segments, but it has also been relevant for increasing our financial inclusion in Banco de Chile. In addition to our progress in the FAN product, we advance in improving other digital initiatives that are focused on internal processes. These changes have resulted in boosting our productivity by a staggering 35% year-on-year in current account originations. In line with our commercial initiatives, we launched new accounts for companies in USD, yen, and British pound. These accounts offer diverse functionalities, including foreign exchange transactions, financing options for customers operating internationally. We also upgraded our personal banking credit products by introducing new pre-approved credit lines and credit card limits, resulting in a 25% increase in the average number of these operations.

New installment options were released for credit card balances, providing customers with more flexibility to pay their debt. Our constant innovation and commercial initiatives enabled us to offer customers a wider range of product options, strengthening our relationship and enhancing our ability to meet their financial needs. In terms of ESG reporting, this quarter we published our 2024 annual report, which covers our financial and sustainability performance and marked significant advances in meeting local and international standards such as SASB and GRI. All of these initiatives position us to maintain our leadership in the banking industry and prepare us confidently to navigate future opportunities and challenges. Please turn to slide 12 to begin our discussion on our results. We started 2025 with solid results of CLP 329 billion this quarter, equal to a return on average equity of 23.3%, as shown on the chart to the left.

When compared to our peers, we outranked all of them in both market share and return on average assets, as shown on the chart to the right. Specifically, in market share, we achieved a 22.8% participation in net income, and in return on average assets, we reached 2.5%. Our robust financial performance underscores our enduring customer-centric approach and commitment to establishing a sustainable bank, as evidenced by consistent increases in customer revenue, risk management, and positive advances in cost control. In line with this expansion, our aspiration is to be the industry leader in profitability. Let's take a closer look at our operating income performance on the next slide 13. We continue to demonstrate the strongest operating revenues in the industry thanks to our superior business model and its clear resilience through market cycles.

On the chart on the left, we see a consistent operating revenue growth quarter-over-quarter, despite subdued business dynamism, by totaling CLP 779 billion in the Q1 of 2025. This was composed of strong customer income amounting to CLP 617 billion, up 4.3% year-on-year, and non-customer income that reached CLP 162 billion, below the CLP 188 billion recorded a year earlier. The decrease in non-customer income was mainly caused by the maturity of FCIC funding from the central bank in the first half of 2025, which explained CLP 75 billion in higher revenues in the Q1 of 2024 when compared to the same period of 2025. This was partly offset by higher revenues from directional inflation index positions.

This decline was partially offset by an annual rise of CLP 20 billion in the contribution of our structural U.S. index net asset exposure that hedges our equity against inflation due to higher inflation that increased from 0.8% in the Q1 of 2024 to 1.2% in the Q1 of 2025, as well as the larger UF gap on the balance sheet. In terms of customer revenue, growth was driven by income from loans and fees that were up 7.2% and 14% year-on-year, respectively. The consumer loan book contributed to the most of the loan revenue, which increased by adding CLP 9.8 billion due to higher lending spreads and 3.5% annual rise in average loan balances. The remaining increase was fostered by improved lending spreads in both the commercial book and the residential mortgages, which resulted in further income by CLP 4.6 billion and CLP 2.4 billion, respectively.

It's also worth noting that most of the growth in the commercial loan book was from SME loans, and that lending spreads in this business unit are gradually returning to normal as FOGAPE loans continue to mature. Likewise, the SME banking unit managed to grow above 8% year-on-year in other than FOGAPE loans. As a result, our net interest margin reached 5% this quarter, significantly outperforming our peers. In turn, the increase in fee income was primarily conducted by transactional services and mutual fund management. Transactional services experienced a rise of CLP 12 billion, partly driven by a favorable exchange rate impact on fee expenses related to our credit card loyalty program due to the Chilean peso appreciating 4% against the U.S. dollar in the Q1 of 2025, compared to a depreciation of 12.3% in the Q1 of 2024.

The remaining increase was due to a rise in credit and debit card transactions of 9.7% and 7.8%, respectively. Fees for mutual funds and investment funds management grew by 22.8% year-on-year. This growth was driven by an 18.4% increase in average balances of assets under management. Furthermore, stock brokers and investment banking also posted increases in their year-on-year performance, fueled by a rebound in the local stock market over the last months, and particularly M&A transactions carried out in the local market. In terms of our fee margin over average interest-earning assets, we are posting strong levels, as shown on the right side of the slide, with a 1.4% ratio as of the Q1 of 2025, also above our peers. Our remarkable operating revenue performance is responsible for an impressive operating margin of 6.7% this quarter.

This achievement is proof of our consistent business strategy and our ability to deliver enhanced value offerings to our premium customer base over time in both lending and non-lending products. As a result, we have established a solid track record in customer income regardless of economic conditions. Please turn to slide 14 to take a deeper look at our loan portfolio performance for the Q1 of 2025. As shown on the left, total loans reached CLP 39 trillion, marking a 1.1% increase compared to the previous quarter and a 3.2% increase year-over-year. We expect this pace of growth to transition in the coming quarters to more normalized levels in line with the better economic figures that we are seeing. Generally, there's a lag of a few quarters when we start to see positive figures in the economy to translate into loan growth.

In this regard, although loan growth multipliers to GDP will probably remain below average levels seen in the past decade, we believe the rebound foreseen in private investment this year and enhanced household consumption should drive more dynamism in commercial and consumer lending in coming quarters. In terms of composition, personal banking-to-commercial loan mix continues increasing. The retail portfolio drove loan growth. This book is comprised of individuals and SMEs, representing 65% of total loans, expanded 5.6%, while wholesale lending remained basically flat year-on-year. Specifically, mortgage loans led the rise, up 8.1% year-on-year, reaching CLP 13.5 trillion. Despite higher than pre-COVID interest rates, this segment has proven resilient, with originations for new loans rising 12% year-on-year. Industry-wise, residential mortgage loans grew 6.3% year-on-year, allowing us to post market share gains, rising from 15.3% to 15.6%. Consumer loans increased by 3.9% year-on-year to CLP 5.5 trillion.

Although this growth is below historical levels due to high interest rates and persistent unemployment, a gradual improvement is anticipated if the trade war does not escalate and affect the local economy. Commercial loans to SMEs reached CLP 5.2 trillion, up 3.7% year-on-year. This expansion has been negatively impacted by significant growth in prior periods in FOGAPE government guaranteed loans that are amortized at a high rate, offset by FOGAPE loans that have expanded the rate of 8.2% year-on-year. On the other hand, commercial loans in the wholesale banking segment remained flat year-on-year. Originations in this segment offset the negative impact of exchange rates on foreign trade loans and lower demand for this product.

When setting aside the potential effects of the trade war on both global and the local economy, we expect this segment to grow throughout the years on the grounds of expected reactivation in the private investment, regardless of the lag between economic figures and demand for loans. Please turn to slide 15 to discuss our comparative balance structure. As depicted in the charts on the top left, our assets and liability structure is solid. Our business strategy is primarily focused on commercial banking, with loans constituting 73% of total assets as of March 2025, while financial instruments represent only 10%. Also, I want to highlight that our held-to-maturity portfolio represents less than 2% of total assets.

This is relevant because during the pandemic, we and most of our peers increased the level of these financial instruments, which generally yield significantly lower than the current market rates, thus affecting net interest margins. On the liability side, deposits are the main source of funding, representing 56% of our assets. Within deposits, time deposits are the most relevant financing source on our balance sheet, followed by demand deposits, one of the most important comparative advantages that we have, as you can see on the chart to the right. Zero-interest bearing demand deposits funded 37% of our loans, a significantly higher ratio than our peers and one of the drivers of our net interest margin advantage. Also shown on the table on the bottom, on the bottom left, we have a high level of liquidity that largely exceeds the limits set by the regulator.

Our liquidity coverage ratio reached 186% as of March 2025, 86 percentage points higher than the regulatory limit, and the net stable funding ratio reached a level of 119%, 29 percentage points higher than the limit during the same period. In addition, it's worth noting that our UF asset gap was CLP 9.7 trillion by the end of March 2025, meaning that our sensitivity to 1% inflation is about CLP 97 billion in net interest income. It's important to mention that this gap is composed of two parts. First, we have a UF position that is structural, which is related to a hedge of capital against inflation. Second, we have a directional UF position that is managed by Treasury to profit from the differential between the Chilean peso and UF rates in the short term.

Given recent inflation trends, which have remained above the central bank's target range and the Treasury's expectations on how inflation will evolve going forward, we have temporarily increased our UF position overall. The income obtained from the strategy has clearly offset the risk taken, which is well controlled by the solid corporate governance we have in these matters. Please turn to the next slide, 16, to discuss our sound capital base. Banco de Chile is the best capitalized bank among its peers in the industry. As of March 2025, our Basel III ratio stood at 17.4%, significantly surpassing our fully loaded requirement of 12.4%, as indicated on the accompanying table. Our CET1 ratio shows a decline this quarter due to effects of payout in dividends that exceeded the 60% amount provisioned as of December 31, 2024, following our shareholders' decisions to distribute 100% of the distributable earnings from 2024.

Despite this reduction, our CET1 trend over the past few years has significantly outperformed both our main competitors, as illustrated in the chart on the bottom left, and remained well above the regulatory limit. Based on these strong capital levels, we are comfortably meeting our phase in Basel III requirements, while remaining confident in addressing the final steps in Basel III implementation. More importantly, given this scenario, we possess the necessary capital to pursue growth opportunities should market conditions permit. Please turn to slide 17. In the Q1 of this year, expected credit losses reached CLP 90 billion, 20% lower than the same period last year and 13% lower when compared to the Q4 of 2024. Cost of risk for the period dropped to only 0.93%, below our long-term expectations. As discussed in previous earnings calls, delinquencies have shown signs of stabilization, as illustrated in the accompanying charts.

The top right chart demonstrates our performance relative to our peers. Notably, we recorded non-performing loans of only 1.5% this quarter, which is significantly lower than that of our peers. The bottom right chart provides a breakdown of this figure, indicating that NPLs have started to stabilize by products and have even improved for consumer loans. We believe that if the economy continues to strengthen and uncertainties decrease, we could observe a moderate improvement in NPLs across products. The chart on the bottom left indicates that our loan portfolio has a coverage ratio of 2.6 times, including additional provisions amounting to CLP 631 billion, which is the highest amount in the local banking industry, while positioning us favorably for managing unexpected credit risk deterioration.

These additional provisions are particularly valuable in uncertain times as they provide a robust buffer against potential negative economic scenarios that could arise in the global economy. It's also important to note that the CMF standardized provisioning model for consumer loans went into effect in January 2025. To mitigate the CLP 69 billion pesos expected impact on risk expenses for 2025, we released additional provisions as anticipated in previous calls. Please turn to slide 18. This quarter, expenses amounted to CLP 281 billion pesos, 1% lower than the same period last year and 7% less than the Q4 of 2024. This decrease is even more significant when adjusted for inflation, as most cost items are linked to CPI variation, which reached 4.9% over the past 12 months.

These figures reaffirm our commitment to productivity and efficiency, which is supported by a digital strategy that has demonstrated to be effective and strict cost control initiatives. In more detail, as shown in the chart on the top right, the annual contraction was mainly explained by lower admin and personnel expenses. The CLP 2.1 billion decrease in admin expenses was primarily driven by reduced fixed assets, maintenance costs, and IT expenses. Regarding personnel expenses, the CLP 494 million decrease was mainly explained by lower total salary, in line with an annual decline of approximately 7% in headcount. This was a result of efficiency initiatives we have deployed over the past years, aimed at increasing our productivity with a comprehensive approach. These factors were partially offset by an increase in severance payments related to organizational restructuring, as certain functions have been centralized and optimized.

In terms of our efficiency ratio, during the Q1 of 2025, we achieved a 36.1% level, which is comparable to the ratio recorded in the Q1 of 2024, which is noteworthy as revenues continue to normalize. The chart on the bottom right shows our consistent track record of efficiency and how we've been able to reach lower levels than prior to the pandemic. We're confident that through effective cost management, enhanced productivity, and strategic use of technology, we will sustain our strong efficiency levels, aiming for approximately 39% in 2025 and maintaining below the 42% in the long term. Please turn to slide 19. Before moving to questions, I want to go over some key takeaways.

Despite the several risks and significant global uncertainties affecting our GDP forecast of 2% for this year, Chile's strong economic fundamentals and our ability to implement countercyclical measures will be crucial in mitigating potential negative impacts. Banco de Chile is uniquely positioned to address these challenges due to our exceptional customer base, superior asset mix, and quality, as well as having the highest coverage ratio among peers. We remain confident in our ability to sustain our status as Chile's most profitable bank over the long term. Our commitment to innovation, customer satisfaction, and prudent risk management will continue to drive our success and ensure sustainable growth. By adapting to market changes and prioritizing our customer needs, we may aim to maintain our industry-leading position for years to come. Thank you, and if you have any questions, we'd be happy to answer them.

Operator (participant)

Thank you very much. We'll now move to the Q&A part of the call. If you'd like to ask a question, please press star to on your phone and wait to be prompted. We'll give a few more moments for the questions to come in. Okay, so our first question is from Yuri Fernandes from JPMorgan. Your line is now open. Please go ahead, sir.

Yuri Fernandes (Executive Director)

Thank you, everyone. So I would like to ask maybe to Pablo regarding capital here for Banco de Chile. As you explained the presentation in this slide, you have a lot of capital, right? You just pay dividends, but you are well above peers. I think CMF had some discussions on adjustments on market-related capital, Tier 2 pillars. My question is the following, Pablo. With more visibility, let's say you start to have more visibility, how Banco de Chile would deploy this excess capital, right? Should we expect at some point? I know this is a recurring question for you, but should we expect more dividend payouts for you?

Should we see M&A? Should we see loan growth? Just trying to understand and if you can provide some numbers. I remember in the past, I think you used to say that 200 basis points, 250 basis points above the minimum requirement was somewhat the goal. Just checking if that continues to be the case. Thank you.

Pablo Mejía (Head of Investor Relations)

Hi, Yuri. I'm here with Daniel Galarce, who will take this question. One second.

Daniel Galarce (Head of Financial Control and Capital)

Hi, Yuri. This is Daniel Galarce. As we have discussed in the previous calls, we are aware that our current positive gaps in terms of capital adequacy and also our position in terms of capital adequacy as well in the local industry. Of course, our Tier 1 ratio, for instance, is 3% or 4% above the regulatory limit.

You have to consider that in March, that ratio decreased approximately 1% due to the dividend payment. As we have emphasized in previous calls, we aim to keep these favorable capital buffers in order to support either future organic growth or also inorganic growth if some opportunities can arise in the future. So in this regard, part of our current capital positions have to do with both subdued loan growth, of course, and also the profitability we have observed over the last five years which has been very non-recurrent, of course, due to different market factors. In addition, I would say that with our current capital buffers, we also need to face, and we have to face, the final phase of Basel III transition.

Of course, there are some pending regulations in the local market, like pillar two, like the pillar two regulation, which is still pending from the CMF side. And this can translate into further capital requirements for banks, including us. It's important to take into account that also the Chilean central bank has announced that probably the countercyclical buffer will convert to an neutral level as well of around 1%. So it's important to note that in terms of our capital composition, we are facing tier one capital needs only with CET1, only with CET1 capital. So given that, and due to the lack of a deep local capital markets in terms of AT1, and also the cost involved in AT1 issuances in foreign markets, we are assessing the possibility of optimizing our capital base in the future.

But so far, we will face capital requirements of Tier 1 only with CET1. So due to that, the 60% dividend payout ratio is our baseline scenario for the future. And accordingly, extra dividends or a payout ratio higher than 60% would be only possible under certain circumstances, basically loan growth below what we are expecting now, and/or results above what we are expecting as well. So if this doesn't occur, probably we will maintain our 60% dividend policy over the next years.

Yuri Fernandes (Executive Director)

No, no, super clear. This is a good problem to have. If I may, just a related question on this topic of good problems for Banco de Chile. The other common one we discussed is your higher allowance is so strong when we add up the additional provisions, right? And this has been coming down gradually. So just checking the box here if there's a number that you go for these, like if you feel comfortable with returning below 200% at some point? Thank you.

Pablo Mejía (Head of Investor Relations)

Well, as you know, the additional provisions. This is Pablo speaking. As you know, the additional provisions that we accumulated were during the pandemic when the level of delinquencies didn't make sense in the economic cycle that we're having. And we began accumulating these additional provisions. One part of this, a portion of this, was used to implement a new consumer loan model that went into effect in January of 2025, so CLP 69 billion. And we still have the rest on the books. So the coverage ratio true has been coming down, but it's been coming down based on NPLs. So how the NPLs have evolved is NPLs in mortgage loans have increased in the industry-wide.

We're significantly below the average in the industry, and we've seen slowing down or actually reversals in the, if we look at year-to-year or quarter-on-quarter in terms of commercial loans and consumer loans. Commercial loans are relatively flat, NPLs and consumer loans coming down a little bit, so since it's a relationship between NPLs and total allowances for loan losses, the number has come down because there's a little bit higher NPL, but there's a lot of guarantees in those NPLs, right, so as we continue to improve, if the economy improves, if everything goes a little bit back to normal, we'll probably start to see a change in NPLs coming down, and maybe the ratio will be higher.

But it's also important to mention that in the case of these additional provisions is that we're in a cycle of a lot of uncertainty right now, especially with everything that's going on globally. So this is very important for us to maintain in these more negative cycles that we can use this if something's affected, not that we're seeing something today, but if something could be affected in the economic sector, customer base, etc., we have those additional provisions. So in the long term, it makes sense, or the medium term, it makes sense that we return to those levels, that either we use them, that there's a use for these additional provisions, we maintain them, or there's a reversal, as we've mentioned in other calls. But there's no clear timeline when that will occur. And today, there's more uncertainties than there were six months ago.

So it's something that we're comfortable with today.

Yuri Fernandes (Executive Director)

No, thank you, Pablo, but there is no number, right? Because this was closer to 400% back in the day. It's too shifty, as you said, just because of NPLs, like the drop in nominal additional provisions was very minimal, right? It went down from CLP 700 billion to CLP 630 billion. It's fine. But some of your peers, they increased it by 1/4, 1/3, by half, right? So is there a number that you believe, like 200% additional coverage, that's fine? Is there a number that you should believe on this number going forward, or not really?

Pablo Mejía (Head of Investor Relations)

If we looked at the averages before the pandemic, we had numbers around 200%, but it was with a different level of additional provisions.

Yuri Fernandes (Executive Director)

Perfect. Thank you very much.

Pablo Mejía (Head of Investor Relations)

Sorry, and NPLs. Thank you.

Yuri Fernandes (Executive Director)

Thank you.

Operator (participant)

Thank you very much. Our next question comes from Beatriz Abreu from Goldman Sachs. Your line is now open. Please go ahead.

Beatriz Abreu (Equity Research VP)

Hi, everyone. Good afternoon, and thank you for taking my questions. My first one is regarding margins. So we saw that you increased the margin guidance to around 4.7, which is now closer to the top of the range that you had previously, even though you now expect a lower level of policy rate at the end of 2025. So if you could give us some color on what made you increase your margin expectations there, are you now more confident regarding any mix changes? And my second question is regarding loan growth. So we'd like to know what are your current expectations for loan growth by segment, and what do you think that needs to happen for loan growth to accelerate above the mid-single-digit levels? Thank you.

Pablo Mejía (Head of Investor Relations)

Hi. In terms of net interest margins, we did have a Q1 that was quite strong in terms of inflation. Throughout the rest of the year, we're expecting that there should be, as long as the global economy isn't impacted materially in Chile, an improvement in terms of mix and the types of loans that we're growing. There should be an improvement in terms of mix. We've been benefiting from the decrease since last year to this year in terms of spreads and the overnight rate, which has decreased, reducing the cost of our time deposits. This has been translated into a slight change.

But in general, the change in terms of our NIM guidance is more or less in line with what we had in the prior conference call, just slight adjustments considering the evolution of the Q1 and expectations for the rest of the year. In terms of, as I mentioned, mix, and there's a little bit of reduction in terms of the guidance of the overnight rate. So we're seeing in the beginning of the year, Rodrigo can go into that, an overnight rate that was a little bit different from what we're expecting today. Rodrigo?

Rodrigo Aravena (Chief Economist and Institutional Relations Officer)

Yeah. Hi, Beatriz. Thank you very much for the question. Just let me add just a couple of ideas. Today, we have more uncertainty in terms of the evolution of key market drivers for profitability, for margins, especially in terms of inflation and interest rate.

Even though in our baseline scenario, we are expecting an inflation rate of around 3.8%, probably 4% by the end of the year, which would be consistent with an interest rate of around 4.25% by the end of the year. These assumptions are consistent with the absence of higher inflation in the rest of the world, and also, these assumptions are based on an exchange rate hovering about the current level, which is around 9.40-9.50, something like that, but we're aware about the uncertainty because we are facing a supply shock where we have lower global growth, but some pressure on inflation, so it's not clear what's going to be the final equilibrium.

But at least for now, we think that it's reasonable to expect some adjustment, minor adjustment, I would say, in the interest rate in Chile, probably 75 basis points from now to the end of the year. We continue expecting a neutral interest rate in Chile, a number between 4% and 4.5%. And inflation will be lower in the future, converging probably by the end of this year toward 3.8%. And probably in 2026, the inflation rate will be around 3%. But again, today, our main source of uncertainty in terms of the key factors affecting margins and profitability are related with macro factors, especially in terms of GDP, interest rates, and inflation in the short term.

Pablo Mejía (Head of Investor Relations)

And going into your second question and tying it into the first one, in terms of where we're growing and what's changed, we're seeing the economy or the economy drops as well. But we're seeing loan growth for the industry dropping a little bit. So the guidance came down there. And probably what we should see is more uncertainty from businesses. So maybe recovery of businesses could be slightly slower. So where we could see probably a little bit better activity is in retail products. So consumer loans is important there. So the mix is slightly different from what we were expecting from the beginning of the year, which would be positive for the net interest margin, slightly less in terms of total loan growth. So what we're expecting is slightly above the levels of the industry, which the industry GDP expectations or sorry, loan growth expectations are around 4%.

For us, slightly above that, and that will be driven by consumer loans and mortgage loans, and we should probably see commercial loans slightly below the expectations that we had earlier in the year, and within the commercial loans, probably a little bit more activity from SMEs than from large companies in general.

Beatriz Abreu (Equity Research VP)

Perfect. Thank you, Pablo and Rodrigo.

Rodrigo Aravena (Chief Economist and Institutional Relations Officer)

Thank you very much, Beatriz. Thanks.

Operator (participant)

Thank you. Our next question is from Neha Agarwala from HSBC. Your line is now open. Please go ahead.

Neha Agarwala (Senior VP)

Hi, [inaudbile]. Thank you for taking my question. Just a quick one. What are the main concerns that you have from a macro standpoint for the year? Earlier in the year, there was also discussion about higher taxes, but I guess that's off the table for now. Is there a risk for that to come back? And my second question is on inflation. This year, inflation, at least so far, has been running higher than expected. How do you see it in 2026? I believe if there's a steeper decline in inflation, that could put more pressure on margins for next year. So how are you protecting yourselves in view of that? And how much of that is being managed by the UF gap that you mentioned during your opening remarks? Thank you so much.

Rodrigo Aravena (Chief Economist and Institutional Relations Officer)

Thanks, Neha. This is Rodrigo Aravena. Thank you very much for your question. In terms of our concerns or our balance of risk that we have today, our main concern for this year is related with the global economy, okay? It's very important to keep in mind, to be aware that Chile is, according to some measures, Chile is one of the most open economies in Latin America. Our total trade volume, for example, is around 55% of the GDP. We have free trade agreements with more than 85%, around 90% of the global economy.

So that's why the evolution of the global growth, especially in our main trade partners, even though the larger trade partner in Chile is China with 40% of the total export, the second largest trade partner is the United States with nearly 16% by the end of the last year. So the evolution of the trade policy, the new measures that could be adopted by the U.S. authorities, the potential impact in terms of economic growth of China is, at least for this year, our main concern in terms of the impact on growth for at least this year. Locally, probably the most important event to monitor this year is related with elections.

We're going to have the Senate election in November this year. There will be Congress elections as well with a total change in the Lower House. They have the Senate. So that's why we have to pay attention to the evolution of the discussion, the proposals, etc. Today, we knew, for example, that a very important survey was released this morning from CEP, Centro de Estudios Públicos in Spanish, that's the name of the company, which showed that nearly 50%-52% of people, they haven't decided their preference for the candidates to their candidates for this year. So we have some uncertainty in terms of who's going to be the president, the composition of the Congress, etc. In terms of taxes, we haven't seen any proposals that put the possibility to change taxes.

In fact, there are some proposals on the other direction, considering, for example, some reduction in the corporate tax. But again, we have to see how the discussion will evolve in the future. In terms of other figures, for example, employment or internal demand, we are not very concerned. Again, it's the global economy and the result of election, the key factor to monitor this year. In terms of inflation, a key factor to monitor is the evolution of the effects because the pass-through in Chile is a number between 10% and 15%, which means that if the exchange rate depreciates, for example, by CLP 90 today, it could have a potential impact on inflation of around 100-150 basis points over the next 12 to 18 months. So we think that the evolution of the exchange rate will be a key factor to monitor.

But if we assume an economic growth of around 2% for this and the next year, relatively stable level of effects, it could be consistent with an inflation rate of around 3.8% and 3% for this and the next year, respectively. In terms of the final part, Pablo is going to take the final part of the question.

Pablo Mejía (Head of Investor Relations)

So in terms of how we've been funding the bank, it's changed over the years, especially if you look at it as an amount in terms of the UF gap on the balance sheet. We're a larger bank. And there's two parts to this. One is a structural part, and one is the position taken by the treasury. So the structural part is somewhere around the CLP 5-6 billion, which means we have more assets than liabilities in USD.

And there's a structural part from the capital, a structural part from the demand deposits, which are in pesos. And that would be the structural CLP 5-6 billion that we have on the balance sheet. And the rest of this position is a treasury position, which is based on the expectations of our treasury area on the evolution of inflation, if interest rates in the different currencies make sense for what they're expecting and how they should fund the bank. So the expectations of the treasury department have led to an increase, a temporary increase in terms of the gap on the balance sheet. And that's what we saw at the close of this Q1. So how that will evolve in the future will really depend on the evolution of the expectations of our treasury department.

But as of today, it's been very successful in generating a greater return in terms of this source of revenues. So the structural gap, around five or six, the rest is around, is a treasury position, and that's based on expectations and temporary factors.

Neha Agarwala (Senior VP)

Right. So could you please repeat the sensitivity that you mentioned earlier?

Pablo Mejía (Head of Investor Relations)

So the sensitivity of 1% change in the UF gap. Today, we have a UF or at the end of the quarter, we had a UF gap of CLP 9.7 trillion. So 1% change in inflation is CLP 97 billion in net interest income.

Neha Agarwala (Senior VP)

Very good. Thank you so much, Rodrigo and Pablo.

Pablo Mejía (Head of Investor Relations)

You're welcome. Thanks.

Operator (participant)

Thank you. Just a reminder, if you'd like to ask a question, please press star two on your phone and wait to be prompted. We'll give a few more moments for any new questions. Our next question is from Andrés Soto from Santander. Your line is now open. Please go ahead.

Andrés Soto (Executive Director - LatAm Equity Research)

Hi, Rodrigo Pablo. Thank you for the presentation. My question is regarding your medium-term ROE target. I see on your presentation on slide number nine that your medium-term target is to be top one versus top two right now. You are trailing your main competitor. So I would like to understand how are you seeing ROE evolving in the medium term, given that you continue to deliver above-average levels of ROE and considering your structural changes in terms of loan growth, sorry, in terms of loan composition and in terms of expenses, also considering a significant drop in headcount that we have seen since the pandemic.

I would like to understand if Banco de Chile is expecting to be able to deliver, let's say, around 20% or even above 20% ROE over the medium term, considering that that's sort of the expectation that your main competitor has been stating.

Pablo Mejía (Head of Investor Relations)

Thank you, Andrés. In terms of our ambition, our ambition is to be the most profitable bank in Chile in all the cycles. Obviously, it depends on the cycle and what the expectations of each bank is for that cycle and return to growth of the economy. That's our long-term expectation; ambition is to be the most profitable bank. We have the robust capital base in order to navigate the potential regulatory changes and to hopefully take on growth when growth comes back. It's very important to mention that we have the capital to grow if we need to.

And that will obviously promote an attractive ROE for us in the future. So I think that would be the most important to mention is that our ambition, our long-term ambition with everything that we're doing, is to be the most profitable bank in Chile. So this year, we've revised our ROE forecast up or our ROAA forecast up to around 20% from the previous levels because of everything that we mentioned in the presentation. And the cost of risk today is around we're expecting around 1.1%, which should be somewhere similar to those levels, 1.1%, 1.2%, if we go back to the same mix that we had in the past. So the position of the bank today allows us to continue to grow in an important manner in the future if that's available. And that will allow us to continue posting attractive returns.

Andrés Soto (Executive Director - LatAm Equity Research)

Regarding the loan growth comments that you are making, what will be a reasonable number for loan growth over the medium term or even in 2026? In 2025, you say it's going to be a lag between recovering private investment and that will be translated in terms of loan growth. But for 2026, can we expect high single-digit level of loan growth, or what is the multiplier that you are seeing to loan growth once those factors abate?

Pablo Mejía (Head of Investor Relations)

I think there's uncertainty because of everything that's happening, much more today than there were three months ago, six months ago. What we would expect is that there's a lot of pent-up demand in the pipeline. This could increase maybe higher than the levels of GDP growth elasticity than we've had in the last period. And maybe Rodrigo can go into a little bit more detail in terms of the macro scenarios on how that could occur.

Rodrigo Aravena (Chief Economist and Institutional Relations Officer)

Yes. Hi, Andrés. Thank you for the question. So I think it's important to analyze some structural trends that we've seen in Chile in terms of loans, especially during the last year. So for example, today, the ratio between loans to GDP is around 75%, around that. But it was before the pension fund withdrawal, before the pandemic. That number was between 85% and even 90%. So we've seen an important delay in terms of the loan cycle compared to the cycle of the GDP. So when we adjust by any long-term measure, we would see that given the level of the GDP of Chile, given the GDP expectations as well, the level of loans should be higher than the level that we have today.

We've seen an important delay, for example, in terms of commercial loans because of the lack of investment in Chile. A similar situation we have in terms of consumer loans. We have to understand as well that still the interest rate is on a contractionary level, so it's reasonable to state a recovery of loans in the future. In terms of the multiplier of elasticity, despite in the past, we used to see levels of around two times, that today is very different, but it's reasonable to expect numbers higher than one time, probably 1.4, 1.5. We don't know. It depends on what's going to happen in the future.

But if we assume that the economy could grow between 2 and 2.5% for the next year, plus an inflation rate between 3 and 3.5%, something like that, plus the elasticity, a more normalized elasticity of loans to GDP, it would be reasonable to state loans for the system growing in high single digits over the next years.

Andrés Soto (Executive Director - LatAm Equity Research)

That's very clear. Thank you, Rodrigo.

Rodrigo Aravena (Chief Economist and Institutional Relations Officer)

Thanks.

Operator (participant)

Thank you very much. I will now hand it to Pablo and Rodrigo for the closing remarks.

Pablo Mejía (Head of Investor Relations)

Thanks for listening. And we look forward to speaking with you on our next quarterly results. Bye.

This concludes the call. Thank you and have a nice day.